Virtually all economic and financial markets have been impacted by the COVID-19 pandemic that erupted since January 2020. As global governments take measures to stem its spread by imposing economic lockdowns, countries are experiencing increasing unemployment, broad declines in aggregate consumer demand, soaring inventory levels, and reductions in production.
To mitigate the economic fallout, many governments have also taken various measures including providing various forms of grants and short-term economic aid, permitting short-term relief from various forms of contractual obligations including rental and loan obligations, as well as short-term relief from insolvency. All of the above measures will have impact on financial reporting under the International Financial Reporting Standards
(1). This article discusses certain key accounting and financial reporting considerations related to conditions that may result from the COVID-19 pandemic as well as various industry-specific considerations.
Forecasting Challenges
The use of cash flow forecasts is pervasive in financial reporting, in matters such as impairment assessment, valuation of unquoted assets, and the assessment of the recoverability of deferred tax benefits. The pandemic has created unique challenges in this respect. It has resulted in a very wide range of possible outcomes, arising from uncertainties such as those concerning the ultimate trajectory of the pandemic, uncertain regulatory responses to pandemic developments, the extent to which the financial markets will react to the economic fallout, and the time that the economy will require to recover. These macroeconomic uncertainties must be translated into specific financial implications on future cash flows based on each entity’s unique circumstances. Although it presents genuine challenges, nevertheless, companies remain obligated to provide their best supportable estimates, with appropriate documentation, and prepare robust disclosures of their assessments, assumptions, sensitivities, and other required matters. In some cases, such best estimates may have permanent repercussions on the strength of a company’s financials, such as in the case of goodwill which, once impaired, cannot be written back in the future even when the situation improves.
Financial Assets
The recent severe volatility in the financial markets arising from the pandemic will impact the fair value of many financial assets and liabilities. The recent decline of West Texas Intermediate crude futures below zero is a case in point. Nevertheless, where the market for a financial instrument remains active, the market price at the balance sheet date is still required to be regarded as the best indicator of fair value for financial reporting purposes.
Expected credit loss (“ECL”) assessments of debt assets will become more challenging. Other than debtor credit issues arising from the global economic fallout from the pandemic, consideration must also be given to regulatory directives in certain jurisdictions which directly limit creditors’ ability to take action to recover debt, e.g. by falling back on collateral. In March 2020, IASB issued guidance material
(2) on measuring ECL under COVID-19, which emphasised that ECL computation is not mechanistic. For example, the extension of payment holidays to all borrowers in a particular class of financial instrument should not automatically result in a significant increase in credit risk for all of those instruments.
With the operational disruption arising from the pandemic, there may be significant delays and disruption in the fulfilment of contracts, and in some cases the contracts may be terminated. Where such contracts are subject to hedge accounting, the hedges may become ineffective, require rebalancing (for hedges that are accounted for under IFRS 9
Financial Instruments (3)), or in some cases where the hedge designation is directly linked to the transaction timing, the hedges may no longer be valid. Entities will have to carefully assess their hedge relationships to ensure that the hedges remain effective, and make appropriate accounting adjustments for terminated and modified hedges.
Subsequent Events
As COVID-19 progresses, entities need to consider the various stages of development in the pandemic, assess whether each development has occurred pre- or post-balance sheet date, and whether any adjustments or disclosures are required as a result of such developments. IAS 10
Events after the Reporting Period (4) differentiates between adjusting events, which occur prior to the balance sheet date and impact the financial numbers, versus non-adjusting events, which occurred after the balance sheet date and do not impact the financial numbers although disclosures may be required.
In March 2020, the Institute of Singapore Chartered Accountants (“ISCA”) issued its view in Financial Reporting Bulletin (“FRB”) 2 Accounting implications arising from COVID-19 for entities with 31 December 2019 financial reporting date, that the COVID-19 outbreak is a non-adjusting event for entities with a 31 December 2019 balance sheet date. However, as entities progress into 2020, that assessment is likely to change as entities start reporting on post-31 December 2019 financial year ends.
Even as entities move into 2020, careful assessment is still needed to ensure that developments qualify as “adjusting events” before any adjustments are made. For example, although the World Health Organisation has escalated the global risk from COVID-19 to “High” in late January 2020, global equity prices generally started to collapse only in about mid-February 2020, while in Singapore, sweeping travel restrictions (other than from China) only started in March 2020 and circuit breaker measures only started in early April 2020. Legislation requiring forbearance on rental and loan defaults, which may have significant direct financial reporting implications for lenders and landlords, were also passed only in early April 2020 in Singapore, while in other countries similar legislation may have been passed at different times (e.g. late March 2020 in UK). The fluid timetable under which the pandemic and its consequent regulatory directives unfold in each country means that entities need to remain vigilant about the nature and timing of events that have material financial impact. Judgement and care are also required in establishing cause and effect relationships between each development and its financial impact.
Lease Concessions
As a result of reduced business volume arising from the pandemic and the follow-on regulatory directives, certain lessors of commercial and industrial establishments have been approached by tenants for lease concessions.
Generally, where such concessions are considered to be beyond the contractual terms of the original lease agreement, IFRS 16 Leases (5) requires the concessions to be accounted as lease modifications which requires, inter alia, assessing whether a new contract has arisen and/or re-measurement of the lease asset and liability. However, if the lease concession was already offered within the legal framework of the original lease agreement, for example by triggering pre-existing force majeure or disaster clauses, then the concession will not be regarded as a lease modification.
Under existing IFRS 16 requirements, entities will need to perform legal analysis to determine whether lease concessions qualify as lease modifications, which will require an analysis of each lease contract and whether the contractual clauses therein afford the concessions arising from the pandemic. This can be potentially costly given the vast number of leases potentially affected by the pandemic. However, on 17 April 2020, the International Accounting Standards Board (“IASB”) has proposed to provide practical relief by providing lessees with an option to account for COVID-19-related lease concessions as if they were not lease modifications. When the proposal is finalized, lessees will be exempted from the potentially-costly exercise to assess whether the lease concessions constitute lease modifications.
In some jurisdictions, certain lease concessions during the pandemic period may have been received from the local government directly or indirectly, in which case the lessee should further consider whether these fall within the ambit of IAS 20 Government Grants (6). In Singapore, the government has provided property tax rebates to owners of qualifying non-residential properties from 1 January 2020 to 31 December 2020. Where any portion of such properties have been leased out, the owner is legally obligated to transfer the rebate to the lessee. In April 2020, ISCA issued “FRB 5 COVID-19 Government Relief Measures: Accounting for Singapore property tax rebate from the perspective of the landlord and the tenant”, setting out its view that such rebates, provided by a lessor to a lessee, fall within the ambit of IAS 20. However, FRB 5 only applies to lease concessions arising from the mandatory pass-on of property tax rebates by the lessor; any further concessions will have to analyzed separately taking into account the requirements of IFRS 16.
Going Concern
Entities are required to assess the entity’s ability to continue as a going concern for the next 12 months after the date on which the financial statements are issued, taking into account all available information at the issuance date of the financial statements. When assessing the entity’s ability to continue as a going concern, the potential implications of COVID-19 and the consequent regulatory directives will have to be considered. Operational disruption, reduction in revenue arising from lower demand, as well as regulatory prohibition on taking action against debt, tenancy and other contractual defaults, are just some of the factors that may impact going concern. These must be weighed against government support measures, including legislation in certain countries that make it more difficult for creditors to initiate insolvency actions resulting from the pandemic. However, in such circumstances, affected entities need to carefully assess the ability to remain solvent and satisfactorily resolve any credit issues beyond the forbearance period. We expect that generally, the going concern basis of preparation will continue to be used unless the entity either intends to liquidate or cease trading, or it has become clear that the entity has no realistic alternative other than to do so. However, comprehensive disclosures in financial statements should be made when substantial doubt exists about an entity’s ability to continue as a going concern, even when there are plans to resolve such doubt.
Conclusion
The COVID-19 pandemic is a “black swan” event that will have many economic and financial implications, with follow-on implications for the financial reporting of many entities. It is not the objective of this article to highlight all such implications. For example, this article has not discussed the impact on revenue reporting arising from contractual disruption, the assessment of onerous contracts arising from compulsory contractual forbearance, impact on consolidation of structured entities arising from the activation of force majeure change-of-control clauses, accounting for pandemic-related government aid (e.g. period over which aid is to be recognised), among others. This article only aims to illustrate the ubiquitous and wide-ranging financial reporting implications that may arise from COVID-19, with an emphasis on those topics that have been the focus of regulators’ and standard setters’ discussions.
In dealing with the financial reporting impact of COVID-19, entities need to deal with the wide range of uncertain outcomes, and also consider that assumptions made under normal economic conditions may no longer apply. When in doubt, please reach out to your financial reporting advisors.
This article is contributed by Wong Koon Min, Partner and Head of Technical, Compliance and Financial Services at Moore Singapore. To understand more about how we can support your business through these trying times and thereafter to help you achieve your business objectives, contact us today.
(1) Although this article makes reference to International Financial Reporting Standards (“IFRS”), the matters discussed apply equally to financial statements prepared under the two accounting frameworks most commonly used in Singapore, which are the Singapore Financial Reporting Standards (International) [“SFRS(I)”], as well as Financial Reporting Standards (“FRS”).
(2) “IFRS 9 and COVID-19” issued by IASB on 27 March 2020
(3) Also applicable to SFRS(I) 9 Financial Instruments and FRS 109 Financial Instruments
(4) Also applicable to SFRS(I) 1-10 Events after the Reporting Period and FRS 10 Events after the Reporting Period
(5) Also applicable to SFRS(I) 16 Leases and FRS 116 Leases
(6) Also applicable to SFRS(I) 1-20 Government Grants and FRS 20 Government Grants